Factors that influence market participants: social norms and sin stocks

June 18, 2014 | Hamilton
Contributed by Heston Tobias, Advancement Intern

fingers_crossedWhen it comes to the financial market, society sometimes places moral judgements on certain stocks. If the stock or product is acceptable by society’s standards, then market agents are usually able to cover and invest in the corresponding stock. However, if the stock or product is condemned by society, then market agents will be stuck in a difficult position to invest in or cover these stocks.

The products that are usually condemned by society are referred to as sin stocks. These stocks contain products that are usually deemed to be unacceptable or dangerous to society. Although societal norms have a large influence over investors and analysts’ decisions to invest and cover sin stocks, the potential  gains from sin stocks can have an equal, if not greater, influence.

Yanju Liu, Assistant Professor of Accounting at Singapore Management University, Hai Lu, Associate Professor of Accounting at the Rotman School of Management, and Kevin Veenstra, Assistant Professor of Accounting and Financial Management Services at the DeGroote School of Business, find through their research that when a sin stock’s financial performance is expected to be high, market investors and analysts will choose the sin product’s financial incentive over their society’s ethical imperative.

When trying to answer the question of whether a financial agent would choose the financial incentive of a sin stock over society’s norms, Liu, Lu, and Veenstra carefully examine the following: the evolution of social norms and proxies of the consumption of sin products.

The Evolution of Social Norms

When examining the evolution of social norms, Liu, Lu and Veenstra distinguish between descriptive norms and injunctive norms:

…society’s interaction with sin stocks and their perceived attitudes to such stocks…influence[s] both investors and analysts’ interaction with sin stocks.

Descriptive Norms: Norms that describe the prevalence of a behaviour in a particular society. For example, a descriptive norm would refer to how many people in a particular society consume alcohol.

Injunctive Norms: Whereas descriptive norms describe the prevalence of a specific behaviour in a society, injunctive norms refer to the degree that the society approves a behaviour. For example, in regards to a society’s consumption of alcohol, an injunctive norm would look for what is considered in a society to be a tolerable amount of alcohol to consume and what is considered to be an excessive amount.

These norms are important to Liu, Lu and Veenstra’s research because it allows them to carefully understand how a society’s interaction with sin stocks and their perceived attitudes to such stocks also influence both investors and analysts’ interaction with sin stocks. To get a more realistic understanding of the evolution of social norms, Liu, Lu and Veenstra examine a variety of data concerning society’s use of three key sin stocks—alcohol, cigarettes, and gambling—to use as a proxy for society’s attitudes towards sin stocks.

Proxies: Society’s use of Alcohol, Cigarettes, and Gambling

iStock_000003438077SmallLiu, Lu and Veenstra examine several different dimensions, including age groups, social groups and social classes, to get a holistic picture of a society’s attitudes towards the three sin stock classes. The researchers use this data as a proxy for social norms because they find that consumption data is both consistent with the definition of descriptive norms and are strong indicators of ‘sin’ behaviour. Using verifiable descriptive and injunctive statistics, Liu, Lu and Veenstra find that a higher social acceptance of a stock correlates with higher institutional ownership and analyst coverage of that stock. However, in regards to the three sin stocks, the researchers find two important qualifications that give a new insight into the relationship between social norms and a market agent’s behaviour:

  1. When a sin stock’s firm is expected to perform poorly, society’s norms tend to have a greater influence over institutional owners and analysts’ decision to invest in and cover these stocks.
  2. When a sin stock’s firm is expected to perform well, institutional owners and analysts will tend to choose the financial incentive of the stock over the moral-ethical imperative of society’s norms.

These results demonstrate that although society’s norms influence investors and analysts’ decision to cover sin stocks, the financial incentive of the sin stock can have an even greater impact.

Liu, Lu and Veenstra’s research adds to the growing literature on market participants’ relationship with both sin stocks and social norms. Their unique method of using consumption data as a proxy for society’s attitudes to sin stocks not only overcomes the barriers of believing that societal norms are constant, but it also gives investors and analysts a comprehensive explanation of the societal and financial incentives that influence their decisions.

Yanju Liu, Hai Lu, Kevin Veenstra, “Is sin always a sin? The interaction effect of social norms and financial incentives on market participants’ behavior”, Accounting, Organizations and Society


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